If you are wondering how to understand financial statements this course is for you. I am going to explain all of the necessary things you will need to understand how do to analyze financial statements. If you are just taking the very first steps in understanding how to invest in stocks, learning about financial statements should be very high up on your list of things to understand. For anyone that is trying to understand the stock market for beginners, the two big first building blocks will be understanding the fundamentals of what the stock market is, what stocks are, and then learning how to analyze a company. A perspective investor would want to understand the basics of a company and what the financials of the company show.
In this section I will break down gross profits. Gross Profits are an important part of the financial statement. Gross profits encompass three main lines of the first portion of the revenue statement. Understanding gross profits is the first step in understanding how well a company has performed. This is one of the first thing an analyst will look toward when determining how well a company has performed.
What are EBITDA Profits, Net Earnings, and EPS
When you set out to determine how well a company has performed you will look within the financial statements. There are three sections of financial statements for a publicly traded company:
A company’s performance is determined by several metrics. The first is revenue and profits. This is followed by total equity which is shown in the balance sheet.
The Income Statement is broken down into smaller sections:
- Gross Profits
- Operating Profits
- Continuing Profits
These are the three sections of the income statement. But, within these three sections there are several other lines that break down how a company has performed during a period of time.
Here is the Apple financial data from the Nasdaq website for AAPL stock.[1]Nasdaq AAPL Stock Financial Data. Above, you can see for the annual period ending in 9/25/2021,
Earnings Before Interest and Tax was at $109.2B. This is EBIT.
EBITDA & EBIT
There are two metrics, and neither is a GAAP-standard metric:
- EBIT
- EBITDA
What is EBTIDA? First, EBITDA is an acronym for Earnings Before Interest Taxation, Depreciation, & Amortization. If you are wondering what is EBITDA, this is a non-GAAP standard measure that shows what a company earned from revenues, less cost of goods and operating costs. It is a useful metric for a new company that is still in the process of scaling up revenue to achieve overall profitability. EBITDA as a metric shows where the core business is on a profitability basis just before the cost of capital and financing costs in the financial statements.
For companies that are scaling up their operations, achieving EBTIDA profitability is a key milestone after sales have begun. From a EBITDA basis, should a firm achieve EBITDA profitability, the core costs of producing the product or service have been achieved. From this point, a firm would need to continue to scale up sales and revenues to cover the costs of financing the firm’s operations.
EBIT is the same metric however, it encompasses depreciation & amortization (D&A in EBITDA) in the metric.
How To Use EBTIDA Profitability Metric
If a firm is EBITDA profitable then they can pay for the core costs of producing their products. But, this does not afford for the financing costs of the operations. However, after continued scaling up of operations, a firm should achieve net earnings profitability.
But, with EBITDA profitability, this shows that a firm’s plan could be profitable and that after continual scaling up, with marginal revenues & marginal profits, outsized profits will increase at a higher percentage basis.
EBITDA profitability
There are different levels of profitability. A firm will either be EBITDA unprofitable or profitable. Then, a firm will either be Net Earnings unprofitable or profitable.
It should be noted that a company is usually, but not always, EBITDA profitable before they can be Net Earnings profitable. The reason boils down to the core business operations. And, whenever a firm is Net Earnings profitable without having achieved EBITDA profitability, it is typically owed to something outside of the core business. This portion is found in the Continuing Costs segment of the financial statements and is usually found in the Unusual Earnings/Expenses.
Earnings before Income Taxes
The second metric is the Earnings Before Income Taxes (EBIT) section. This could be an important metric if you are comparing international companies or, if you are comparing two companies within one country and want to see which company is more effective at generating after-tax income. Separating out this metric will enable an analyst to determine which company is more effective at generating after-tax income.
Net Income
The final, bottom line item in the income statement is net income. Net income is the amount of income, on a whole basis, after all revenue is aggregated and all costs are deducted. This is the profit to all of the shareholders. This is what drives ownership of shares in a company.
Net income is expressed as a whole number, not as a ratio. But, there are two potential ratios that could be expressed for net income.
Net Margins
Net margins are simply the total net earnings, or net income, divided over top of gross revenues. This ratio gives
Earnings Per Share
Earnings per share are a ratio. The total net income is divided by the total shares outstanding. This shows how much on a per share basis each share gained or loss, depending upon what total net profits were.
Earnings Per Share (EPS)
As mentioned just above, Earnings Per Share – EPS – is a ratio. It is the total earnings each share has gained or losses depending upon the total net earnings.
In the case above with Apple, there are 17.545B shares outstanding. And, net income was $94.680B. This is approximately $5.68 EPS given the above income and total shares outstanding. This is for the entire fiscal year ending in 9/25/2021.
Understanding EPS is an important metric to know. By looking at ratios, this can enable an investor to make comparative examples with looking at two different companies. In the above example, the $5.68 EPS is merely a number unless you begin to compare that number to another company.
Understanding Yield & EPS
EPS can give a ratio that is useful to analysts. For example, at the time of this writing, AAPL stock was trading at $150.00 per share. If you take the $5.68 EPS and divide that over the $150.00, this gives you yield of what owning AAPL stock will profile relative to the earnings. In this case, AAPL yield, trailing-twelve months, is 3.7%. Again, this is a number. The question becomes, is this a good number?
Comparing companies to one another to understand yield is one method of putting together comparisons and asking the question could one investment be better than another?
For instance, two companies could have the same $5.68 EPS. Which is better? One way to help determine that is using yield as a method of understanding which stock could potential increase more. AAPL is trading at 3.7% yield on a trailing 12-months basis. But, what if the second company has a $5.68 EPS but, the stock price is less than the $150.00 share price for AAPL? This could indicate that the second stock has a higher upside opportunity.
Another thing to look at within EPS & Yield is what does the market anticipate in the coming year? The market may anticipate different things with the two stocks. This could push the price of each stock upward or downward depending upon what the economy may have in store for the future, or overall expectations for each company.
References
| ↑1 | Nasdaq AAPL Stock Financial Data |
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